The allocation of resources - Price changes (3)
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1.
Consider the market for petrol. (a) Describe how a change in the cost of production will affect the supply curve. (b) Suppose there is a decrease in the cost of production. Draw a new supply and demand diagram to illustrate the impact on the equilibrium price and quantity of petrol. (c) Explain how the change in the supply curve affects the consumer surplus and the producer surplus.
(a) A change in the cost of production will cause the supply curve to shift. If the cost of production decreases, the supply curve will shift to the right. If the cost of production increases, the supply curve will shift to the left.
(b) A decrease in the cost of production shifts the supply curve to the right. The new equilibrium will be at a lower price and a higher quantity. The diagram should clearly show this shift.
(c) A rightward shift in the supply curve generally increases consumer surplus. With a higher quantity supplied, the price tends to fall, benefiting consumers. Producer surplus increases. Producers are now selling at a higher price, so their surplus increases. The area representing the increase in producer surplus is the area between the old and new equilibrium, and the increase in the price.
2.
Question 3: Consider the market for mobile phones. Explain how a technological innovation that reduces the cost of producing mobile phones would affect the equilibrium price and quantity of mobile phones. Use diagrams to support your answer.
Answer:
Explanation:
- Technological Innovation & Supply Shift: A technological innovation that reduces the cost of producing mobile phones will increase the supply of mobile phones. This causes the supply curve to shift to the right (S1 to S2).
- New Equilibrium: The rightward shift in the supply curve results in a new equilibrium point where the supply curve (S2) intersects the demand curve (D). This new equilibrium will have a lower equilibrium price (P2) and a higher equilibrium quantity (Q2) compared to the original equilibrium (P1 and Q1).
- Impact on Price and Quantity: The price of mobile phones decreases, and the quantity bought and sold increases. This is because producers are now able to supply more mobile phones at each price level, leading to greater availability and lower prices for consumers.
- Diagram: A diagram should be drawn showing the original supply and demand curves, the rightward shift of the supply curve, and the new equilibrium point. The diagram should clearly label the axes, the curves, and the equilibrium points.
3.
Question 2: Draw a demand and supply diagram to illustrate the effect of a change in consumer income on the price and quantity of a particular good. Explain your diagram, showing how the demand curve shifts and the resulting changes in equilibrium price and quantity.
Answer:
Diagram:
A demand and supply diagram should be drawn. The diagram should clearly label the axes (Price on the vertical axis, Quantity on the horizontal axis). The demand curve should be downward sloping (D), and the supply curve should be upward sloping (S). A point where the D and S curves intersect represents the equilibrium price (Pe) and equilibrium quantity (Qe).
Explanation:
- Increase in Consumer Income: An increase in consumer income generally leads to an increase in the demand for normal goods. This causes the demand curve to shift to the right (D1 to D2).
- New Equilibrium: The rightward shift in the demand curve results in a new equilibrium point where the demand curve (D2) intersects the supply curve (S). This new equilibrium will have a higher equilibrium price (P2) and a higher equilibrium quantity (Q2) compared to the original equilibrium (Pe and Qe).
- Impact on Price and Quantity: The price of the good increases, and the quantity bought and sold also increases. This is because consumers are now willing and able to buy more of the good at the higher price.
- Normal Goods: This explanation assumes the good is a normal good. The demand for inferior goods (e.g., cheap instant noodles) may not increase with an increase in income.